A Supreme Court ruling in 2015 gave employers who offer retirement plans to employees an enormous wake-up call. Specifically, the employees at a California utility company successfully sued their employer over the cost of participating in their 401(k) plan. The court unanimously ruled that the company failed to meet its legal obligation to do what was in the best interest of its employees because the retirement plans that they made available to their workers charged fees that were significantly higher than average.
Since then, employers in manufacturing, retail, communications, financial, and others have been named in a flood of new lawsuits from employees emboldened by the success of the plaintiffs in California. One paid $62 million to settle out of court and another offered employees $57 million to drop their case. Recently the spotlight shifted to the non-profit sector as several prominent universities became the latest targets of lawsuits alleging that employers have for years turned a blind eye and allowed their workers to be charged excessive fees for retirement plan contributions.
Plans that charge high administration fees are particularly egregious when the underlying mutual fund investment fees and management fees are also excessive. Even worse, if there is no true advice for the employee, an employer can be scrutinized even further. Did someone sit down with each employee, describe the options, and help them decide on an individual investment plan? Often, that answer is no.
Many times, young workers are invested way too conservatively. Other times, older workers make the mistake of “putting all their eggs in one basket.” They make this mistake most often by being over-weighted in large U.S. growth companies and underweighted in small, value and foreign ones.
Hidden Fees Undo Retirement Plan Gains
As an employer, you have an obligation under the Employee Retirement Income Security Act of 1974 (ERISA) to prudently select and monitor the provisions of your employees’ retirement plan. If you have not reviewed your plan recently, then the 2015 ruling by the Supreme Court should provide you with an incentive to do so.
The first step is to know exactly what fees the provider of your retirement plan charges. Whether you are evaluating your current plan or choosing a new one, be sure to find out the full details regarding the following three areas:
1. Investment fees. These are by far the largest expense associated with a retirement plan, and they may not even be apparent because they are generally deducted directly from investment returns. Employees might think they are doing well because their monthly statement shows a $500 gain, but they would probably feel differently if they discovered their investment really earned $600, and fees amounting to $100 were deducted before the remainder was credited to their account.
Help your employees by making sure that low-cost index funds are available in your plan. Index funds strive to match rather than out-perform the market, and the savings that can result from this “hands-off” approach often result in lower costs for the plan participants who use them.
Offering low-cost index funds will significantly lower your own liability and will likely be doing a huge favor to your employees. Getting the appropriate asset allocation with the low-cost index funds is the homerun for both administrators of 401(k) plans as well as most people’s retirement plans.
2. Administration costs. These fees pay for the expenses of maintaining the plan, which includes accounting, legal services, and filing the appropriate paperwork with the IRS. Optional, and for extra cost, are services such as professional investment and retirement planning advice, daily valuations, online access to accounts, etc. Ensure that these fees are kept as low as possible. Generally, the fewer bells and whistles associated with the plan you offer to your employees, the lower the administration fees will be. The balance between benefits and cost is critical.
3. Individual service fees. They may not affect every employee, so many employers view them as a cost voluntarily assumed only by the individuals who choose to take advantage of the service. An example of this would be a fee charged to an employee who wants to take a loan out against a 401(k) plan; however, they also include fees charged to everyone for allocating their bi-weekly contributions in to the accounts. The definition of service fees can vary greatly, so it is important to know how your plan assesses them and to make sure your employees understand them.
Next Steps
In 2016, the Security and Exchange Commission’s Investor Advisory Committee (IOC) recommended that the SEC take steps to ensure that consumers understand exactly how much they pay in fees, and to show how those fees impact their investment return.
If the SEC approves their recommendation, companies will be required to disclose their fees in terms of dollars instead of expressing them as a percentage. Your employees may be in for a shock when they find out how much it costs to participate in your retirement plan.
It is a good practice to periodically review the terms of your retirement plan and do comparisons. With constantly changing tax laws, you may find a different type of plan that results greater benefits for your business and your employees. At a minimum, you will be sure that the costs associated with the plan you offer are reasonable and well-understood.
Instead of filing lawsuits, your employees will thank you for looking out for their best interests and protecting their nest egg.
James Lange is a CPA/Attorney whose specialty is Estate Planning for clients with significant IRAs and retirement plans. He is the best-selling author of Retire Secure! and The Little Black Book of Social Security Secrets. His newest book is called The Ultimate Retirement and Estate Plan for Your Million Dollar IRA. Learn more at www.paytaxeslater.com.
